Do you live in South Africa? Then please go to HotForex ZA (South Africa) main introduction page.
How to Invest in an ETF Index Fund?
Over the past 10 years, index investing has been touted as the most affordable option for exchange-traded assets. The market mission of ETF stocks is to enable the medium and small investor to work with securities with significant savings on commissions and create a personal portfolio of assets with controlled income.
ETF index funds are a great tool for beginners or those who are not ready for constant technical analysis and prefer passive index investing. You do not need to study every stock in detail – you can trust the experience of professionals and always be in a profitable trend. But as in any trading, ETF trading requires a systematic approach.
What is ETF (Exchange Traded Funds)?
ETF (Exchange-Traded Fund) is an investment asset, the shares (units) of which are traded on the stock exchange on normal terms. This special type of derivatives shows the present value of a portfolio of stocks, bonds or commodities, and is traded as a single security. As a rule, the composition of an exchange-traded fund is tied to the structure of a standard index and practically repeats its dynamics. Today, funds have the right to independently work with exchange-traded assets and add any securities quoted on the exchange to the index portfolio. Therefore, it is necessary to carefully analyze the composition and overall dynamics of the proposed “basket of shares”, since synthetic assets can be both more profitable and worse than a pure index.
The turnover of ETF assets assumes the presence of a primary market (issue and redemption of the fund’s shares) and a secondary market (exchange and over-the-counter circulation). Only persons authorized by the fund (authorized participants) are admitted to the primary market, the secondary market is available to ordinary participants (legal entities and individuals) without restrictions in capital and qualifications.
Merits of investing in ETFs
- 1. Low transaction costs
- No portfolio management fees for ETF investing in indices and minimal exchange commissions.
- Passive index funds are more trending
- ETFs are less volatile than their constituent stocks – most speculators are cut off when calculating the weighted average price.
- A wide variety of options
- If capital allows, choosing an index fund stock that is growing steadily over the long term seems optimal, but such an investment may require not only money, but constant, complex analysis. So it is recommended to dilute them with actively managed ETFs, such as industry ones, in order to balance the short-term risks associated with a drawdown in the underlying index.
- A low threshold for entering the market
- Anyone can invest in ETF index funds: you can open a deal for one share. The most affordable ETFs cost a few cents, the most expensive hundreds of dollars. The price depends solely on the activity of the market and the state of the economy.
- Margin trading available
- You can use leverage, short trades, pending orders and stop orders.
- High liquidity guaranteed
- The minimum buy/sell difference is guaranteed by the market maker; ETF share price changes throughout the day, and information on the indicative net asset value (iNAV) is also constantly available, which provides much more data for analysis than the dynamics of the main index.
- Active diversification is possible
- By buying an ETF asset, you are already protecting your capital due to the fact that a block of shares is collected inside any fund, and if you collect several funds, then the total profitability of index funds increases significantly.
Demerits of investing in ETFs
- Continuous multivariate market analysis is a must.
- Most of the new indices, which are not tied to the standard exchange ones, do not have time to pass sufficient verification by the exchange before the ETF is issued and become too risky.
- The risk when trading leveraged ETFs is much higher than when trading a conventional stock index.
- Losses are possible in situations of political or economic crises: global, regional, sectoral.
- We need a backup plan for quick reinvestment from index assets into real ones: currency, gold, strong stocks.
- Complex and controversial legal and tax regulation of ETF transactions.
Investing in ETFs is beneficial for market participants who do not have:
- Direct access to common assets;
- Sufficient capital for a standard purchase;
- Operations with assets outside the national stock exchanges;
- Protection of investments from inflation;
- Diversification and hedging of trading capital.
Like any market, index funds require knowledge, patience, and sound money management.